Four weeks ago, I wrote about some red signals that India had to heed in its fiscal and monetary policy. The context was the fragility of the global capital markets and the prevailing nervousness due to Trump’s tariff wars and the rumours that China would retaliate with currency depreciation. In the now, it is the volatility in the Turkish lira markets partly due to Erdogan’s erratic behaviour and partly due to US tariffs. The rupee has been caught like other emerging market currencies. The RBI has quite wisely managed the volatility but not pegged the rupee at any level. The global environment remains fragile. While the tariff wars will, in my view, eventually lead to a set of bilateral deals, the global financial markets are as they were—fast moving and frictionless. This is where India has to get smart.
The depreciation of the rupee and the attendant loss of reserves in managing the volatility should have been seen as a consequence of global forces. These developments have been misrepresented as a sign of weakness or incompetence on the part of RBI. It required an intervention by Arun Jaitley to put the loss of reserves in perspective. But, nationalism is a powerful force and in the months before elections, the Opposition will no doubt describe the weakness of the rupee as a fault of Modi, regardless of the economic absurdity of such a claim. One can only hope that it will not cause the Centre to ask RBI to peg the rupee as the consequence would be a flood of dollars leaving the reserves. There is another cloud on the horizon.
It is not big yet but could darken the economic skies. This concerns the issue of how much dividend the RBI transfers to the government from its income and how much it stashes away in its contingency reserves. The sums are large but are fluctuating, depending on the income and expenditure. Thus, while in 2016, RBI transferred `65,876 crore, in 2017, as a consequence of the cost of printing new currency, it transferred only `30,659 crore. Most recently, for the year ending June 30, 2018, RBI transferred `50,000 crore, having paid an interim dividend of `10,000 crore in March 2018. There are reports in the public domain of a tussle going on between the finance ministry and RBI about RBI putting away money into its contingency reserves which are excessive. Thus, even in the lean year of 2017, RBI put away `13,140 crore into its reserves and paid the Centre `30,659 crore.
The finance ministry says, RBI has `3.76 lakh crore of excess reserves. The ministry criticises the central bank for being too risk averse, using the stressed variance-at-risk (VAR) model which has a 99.99% limit, compared to normal VAR with 99% limits. The finance ministry wants RBI to relax its stringent risk aversion norms and pay more to the ministry. You can sense the annoyance of the dynamic political classes and their loyal bureaucrats with the fuddy-duddy bankers and their caution. What does an extra 0.99% matter? But, caution is in order here. Risk norms are best left to the central bank. Any relaxation has to be openly discussed and carefully implemented if it is agreed upon, between the finance ministry and RBI, that the lowering of the risk norms is prudent. The issue of 0.99% is not a trivial one. To keep the numbers simple, suppose I have a million rupees.
One percent of a million would be 10,000 which I give to you. If I insist on keeping all but 0.01%, you get only 100 from me. No wonder the finance ministry prefers the looser norm. But, come a crisis like September 2008 or the India PSU banks, that are on the brink of bankruptcy, the stricter norm would save the situation. Whatever the right percentage, in these fragile days, no abrupt change should be adopted. If the global financial markets saw that RBI was being prevailed upon by the finance ministry to loosen its purse strings and relax its risk norms, money would leave the Indian shores faster than light.
The rupee would go south and reserves would suffer a huge hit. This is not a matter of Modi or the BJP. Successive RBI Governors have been unhappy with their respective finance ministry bosses. Read the recent books by YK Reddy and D Subbarao. The third Governor to leave caused his own controversy. As Lady Bracknell said, “To lose one parent is a tragedy, but to lose two seems like carelessness”. Same with Governors. As a country aspiring to be in the middle-income status, India needs to assure the financial markets that its norms and procedures are sound.